2013 TheGlobalDeclineoftheLaborShare
- (Karabarbounis & Neiman, 2013) ⇒ Loukas Karabarbounis, and Brent Neiman. (2013). “The Global Decline of the Labor Share." National Bureau of Economic Research, 129(1). doi:10.1093/qje/qjt032
Subject Headings: Labor Share of Income, Capital-Augmenting Technology.
Notes
- It documents declines in labor’s share of GDP in 42 of the 59 countries they studied, including China, India, and Mexico.
- It states that "... the decrease in the relative price of investment goods, often attributed to advances in information technology and the computer age, induced firms to shift away from labor and toward capital. The lower price of investment goods explains roughly half of the observed decline in the labor share ..."
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Quotes
Abstract
The stability of the labor share of income is a key foundation in macroeconomic models. We document, however, that the global labor share has significantly declined since the early 1980s, with the decline occurring within the large majority of countries and industries. We show that the decrease in the relative price of investment goods, often attributed to advances in information technology and the computer age, induced firms to shift away from labor and toward capital. The lower price of investment goods explains roughly half of the observed decline in the labor share, even when we allow for other mechanisms influencing factor shares such as increasing profits, capital-augmenting technology growth, and the changing skill composition of the labor force. We highlight the implications of this explanation for welfare and macroeconomic dynamics.
1 Introduction
At least since the work of Kaldor (1957), the stability of the labor share of income has been a fundamental feature of macroeconomic models, with broad implications for the shape of the production function, inequality, and macroeconomic dynamics. We document that the global labor share has declined significantly since the early 1980s, with the decline occurring within the large majority of countries and industries. We demonstrate how the decline of the labor share can be explained by the decline in the relative price of investment goods. Efficiency gains in capital producing sectors, often attributed to advances in information technology and the computer age, induced firms to shift away from labor and toward capital to such a large extent that the labor share of income declined.
We start by documenting a 5 percentage point decline in the share of global corporate gross value added paid to labor over the last 35 years. We measure the labor share using a novel dataset we compile by combining country-specific data posted on the Internet with sector-level national income accounting data from multilateral organizations obtained digitally and collected from physical books. Our baseline analyses focus on the labor share within the corporate sector as this allows us to circumvent important measurement difficulties confronted by most of the labor share literature. As emphasized by Gollin (2002), aggregate labor share measures are influenced by the methods used to separate the labor and capital income earned by entrepreneurs, sole proprietors, and unincorporated businesses. The corporate labor share is not subject to such imputations. While previous analyses of U.S. data have sometimes focused on the corporate labor share, we are unaware of other research focusing on corporate labor shares in such a large sample of countries.
Of the 59 countries with at least 15 years of data between 1975 and 2012, 42 exhibited downward trends in their labor shares. Of the trend estimates that are statistically significant, 37 are negative while only 9 are positive. We complement our analysis with industry-level data and show that six of the ten major industries experienced significant labor share declines while only two experienced the opposite. Most of the global decline in the labor share is attributable to within-industry changes rather than to changes in industrial composition.[1] The pervasiveness of the decline in the labor share is even present in regional data for the United States, where two-thirds of the states experienced declines over this period.
The decline in the price of investment relative to consumption goods accelerated starting in the early 1980s. We develop a model that relates the decline in the labor share to this coincident decline in the relative price of investment goods. The economy produces two final goods (consumption and investment) using a continuum of intermediate inputs. Technology differences in the production of final goods cause shifts in the price of investment relative to the price of consumption goods and affect the rate at which households rent capital to the firms. Monopolistically competitive firms produce intermediate inputs with capital and labor using a constant elasticity of substitution (CES) technology and sell their output each period at a constant markup over marginal cost. Changes in the rental rate of capital induce producers to change their capital-labor ratios and, for non-unitary elasticities of substitution, the shares of each factor in production costs. Changes in price markups additionally change the shares of each factor in income.
In our model the labor share will only change in response to shocks that influence the rental rate of capital, markups, or capital-augmenting technology, with the magnitude of any response being a function of the elasticity of substitution between capital and labor and the levels of the labor share and markups. Given our focus on long-term trends, we treat the data as being generated from the model's transition from one steady state to another. Assuming a constant household discount factor and depreciation rate of capital, changes across steady states in the rental rate only reflect changes in the relative price of investment. Heterogeneity across countries in the level or growth of any variable other than the relative price of investment, markups, or capital-augmenting technology will therefore not matter for long-term trends in the labor share. This logic argues against the possibility that shocks to other macroeconomic objects such as labor income taxes or household labor supply are important for explaining the labor share decline.
To determine the implications of the declining relative price of investment for the labor share, we use our model to estimate the elasticity of substitution between capital and labor. Most prior estimates use time series variation within a country in factor shares and factor prices to identify the elasticity. By contrast, our estimates are identified from cross-country variation in trends in rental rates and labor shares. Therefore, our estimates are not in uenced by the global component of the labor share decline, the object that we intend to explain. Put differently, even if each individual country experienced a decline in both its relative price of investment and its labor share, there is nothing in our methodology that prevents us from associating a global decline in the price of investment with a global increase in the labor share.
The rental rate of capital can be in uenced at high frequency by various factors such as short-run changes in interest rates, adjustment costs, or financial frictions. These factors, however, are unlikely to have a significant in uence on long-run trends in the rental rate, particularly compared to the relative price of investment goods, which moves proportionately with the rental rate across steady states of our model. Therefore, our estimates focus on lowfrequency variation and only include countries with at least 15, and as many as 37, years of data. Rather than having to use more volatile proxies of the rental rate, this allows us to exploit high quality and widely available data on the relative price of investment.
We start by assuming that capital-augmenting technology growth is orthogonal to the price of investment shock and that the economy has zero profits. In the data, countries and industries experiencing larger declines in the relative price of investment also experienced larger labor share declines. This leads to our preferred estimate of the elasticity of substitution between capital and labor of about 1.25. When confronted with the 25 percent decline in the global relative price of investment that occurred since 1975, our model delivers roughly half of the 5 percentage point decline in the global labor share.
Next, we allow for the possibility that markups affect our estimated elasticity. Imagine that markups increased more in countries with larger declines in the relative price of investment. Even in the Cobb-Douglas case, which features a constant labor share of costs, this would produce a spurious association between declining labor shares of income and declining prices of investment. Our baseline procedure would incorrectly estimate an elasticity greater than one. To address this concern, we use long-term trends in nominal investment rates to approximate changes in the capital-output ratio and follow Rotemberg and Woodford (1995) in using this ratio to calculate capital shares and markups. We find that markups generally increased and therefore did play a role in the labor share decline. However, when we modify our empirical framework to take markups into account, the estimated elasticity, and thus the implied contribution of the price of investment to the labor share decline, is essentially unchanged relative to our benchmark results.
Similarly, our elasticity estimate might be biased upward if capital-augmenting technology growth is greater in countries with larger declines in the relative price of investment.[2] The size of the bias is a function of the covariance between capital-augmenting technology growth and changes in the relative price of investment in the cross section of countries. We show that if the pattern of capital-augmenting technology growth is similar to the pattern of estimated total factor productivity (TFP) growth, then our estimated elasticity is biased upward by0.05. Alternatively, we calculate capital-augmenting technology growth for each country assuming that it accounts for all labor share changes not attributable to changes in the relative price of investment. We find that the implied changes in capital-augmenting technology are uncorrelated with changes in the relative price of investment in the cross section of countries. Therefore, allowing for capital-augmenting technology growth does not alter our assessment of the importance of decline in the relative price of investment for the decline in the labor share.
We also consider the possibility that changes in the skill composition of the labor force impact our estimates and explanation. We modify the production function to allow for two types of labor that are differentially substitutable with capital. We use this framework to estimate the sensitivity of the labor share with respect to the relative price of investment goods, controlling for changes in the stock of skill relative to the stock of capital. Our results show that the declining price of investment goods continues to account for roughly half of the decline in the labor share.
We conclude by using our model to evaluate the implications of our explanation for the decline in the labor share. Our framework abstracts from inequality across households and is only suitable for quantifying the implications of the labor share decline for a representative household. We start by comparing the impact of the observed shock to the relative price of investment in a standard model with Cobb-Douglas production relative to our model with CES production and an elasticity of substitution equal to 1.25. Welfare gains resulting from the shock are nearly a quarter (or 4 percentage points) higher in the CES case. Next, we compare the consequences of two shocks, a decline in the relative price of investment and an increase in markups, each of which generates an equal reduction in the labor share. The differences are stark. A labor share decline due to reductions in the relative price of investment is associated with large welfare gains. The same labor share decline, but due to increases in markups, is associated with modest welfare losses.
Our work relates to several strands of literature. First, our findings are consistent with earlier work by Blanchard (1997), Blanchard and Giavazzi (2003), Jones (2003), and Bentolila and Saint-Paul (2003) that focuses on the variability of labor shares over the medium run, including the large declines seen during the 1980s in Western Europe.[3] Harrison (2002) and Rodriguez and Jayadev (2010) use UN data and are the broadest studies of trends in labor shares. Harrison (2002) finds a decreasing trend in the labor share of poor countries but an increasing trend in rich countries for 1960-1997. Rodriguez and Jayadev (2010) estimate a declining average trend in labor shares using an equally weighted set of 129 countries.
Our results improve and expand upon this related literature. We capture significant movements in the labor share subsequent to 2000, include important non-OECD countries such as China, and use exchange rates to aggregate across countries and examine the global labor share. By focusing on the labor share in the corporate sector, rather than the overall labor share, our results are less subject to measurement problems caused by the imputation of labor earnings in unincorporated enterprises and by shifts in economic activity across sectors. And importantly, we offer novel evidence tying the decline in the labor share to the decline in the relative price of investment goods and compare our mechanism to other potential explanations.
Our work relates the decline in the labor share to the decline in the relative price of investment by estimating an elasticity of substitution between capital and labor that exceeds unity.[4] As reviewed in Antras (2004) and Chirinko (2008) among others, there is a large literature estimating this elasticity. Though the range of estimates is very wide, most estimates are below one.[5] As discussed above, an important difference between our approach and that taken by most papers in the literature is that we estimate the elasticity from cross-sectional variation using many countries and industries and that, by focusing only on long-run trends, we take advantage of cross-sectional variation in the relative price of investment.
Finally, our paper also relates to the literature on investment-specific technical change. Following Greenwood, Hercowitz, and Huffman (1988), and consistent with Hsieh and Klenow (2007), we interpret innovations in the relative price of investment as re ecting investment-specific technology shocks. Greenwood, Hercowitz, and Krusell (1997) study the relevance of this type of shock for growth in the United States. Fisher (2006) documents an acceleration in the decline in the relative price of investment since 1982 and evaluates the importance of investment shocks for business cycles. Perhaps closest in spirit to our narrative, Krusell, Ohanian, Rios-Rull, and Violante (2000) study the evolution of the U.S. skill premium in a model with price of investment shocks and CES production between skilled labor and capital equipment.
Footnotes
- ↑ This decomposition, together with the fact that labor-abundant countries such as China, India, and Mexico also experienced significant declines in their labor shares, argues against a simple role for international trade or outsourcing in explaining labor share declines in capital-abundant countries such as the United States.
- ↑ In our model, the decline in the relative price of investment causes an increase in the capital-labor ratio. Acemoglu (2002) develops a model in which firms choose to direct technological change toward the relatively abundant factor when the elasticity of substitution between capital and labor exceeds one.
- ↑ Blanchard and Giavazzi (2003) argue that deregulation in product and labor markets decreased labor shares and increased unemployment in Europe in the 1980s. Azmat, Manning, and Van Reenen (2012) explore deregulations in the network industry to further advance this argument.
- ↑ As discussed in Barro and Sala-i-Martin (1995) and Jones (2003), a balanced growth path with non-zero factor shares will only emerge if technology growth is labor-augmenting, regardless of the production function, or if the production function is Cobb-Douglas, even if technology growth is capital-augmenting. Acemoglu (2003) and Jones (2005) develop models in which firms choose technical progress to be labor-augmenting along the balanced growth path. If real wage growth or increases in the capital-labor ratio are caused by labor-augmenting technology growth, there need not be movement in the labor share.
- ↑ 5A notable exception is Duffy and Papageorgiou (2000). Leon-Ledesma, McAdam, and Willman (2010) attribute some of the large variation in the estimates of the elasticity to the use of a single equation first-order condition rather than a joint estimation with the production function. Data limitations prevent us from employing their methodology. We note that they find a large downward bias in estimated elasticities from simulated time series when the true underlying elasticity is greater than one.
References
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| Author | volume | Date Value | title | type | journal | titleUrl | doi | note | year | |
|---|---|---|---|---|---|---|---|---|---|---|
| 2013 TheGlobalDeclineoftheLaborShare | Loukas Karabarbounis Brent Neiman | The Global Decline of the Labor Share | 2013 |